2002 In Review: For Global Economy, More Of The Same

2002 was not the turnaround year for the world economy that some expected. Growth was sluggish in both the United States and Europe, as business spending remained stagnant. Economists say 2003 may bring some improvement, but they add that any global growth could be nullified by war in Iraq.

Prague, 12 December 2002 (RFE/RL) -- The outlook for the global economy remains mixed as 2002 draws to a close. It was to have been a modest turnaround year, as the two largest economic areas, the United States and the European Union, were expected to shake off the effects of last year's slowdown and begin recovering. But economic growth in both places was lackluster, as today's good news was largely offset by bad news tomorrow.

The expected boom in the United States never materialized. After starting strong, the economy cooled off at mid-year despite the massive interest-rate cuts in 2001. Worried by mixed signs from the economy, the Federal Reserve in November cut the benchmark U.S. interest rate to its lowest level in more than 40 years.

Peter Jarrett, an economist at the Paris-based Organization for Economic Cooperation and Development, or OECD, blames a series of accounting scandals for eroding confidence in U.S. investment markets and casting a shadow over the entire economy. He said he thinks the corporate accounting scandals "had a great deal of effect on the stock market and on consumers and investors -- companies that were making decisions about spending. It all worked to weaken the second half of the year."

But Jarrett disagrees with the contention that the interest-rate cuts of 2001 had little effect. He said that the reductions, by allowing consumers to continue to buy big items like houses and cars, helped the United States avoid a serious recession. "Monetary policy, clearly, has been what saved us from a very much more severe recession. In the end, it was possibly the mildest recession of the postwar era," Jarrett said.

He said that in his view, it could easily have been one of the worst recessions, if not the worst one, "if monetary policy had been truly ineffective."

Some positive news at the end of the year lifted prospects for 2003. The U.S. government said in November the economy grew at an annual rate of 4 percent during the third quarter (July-September) of the year. That figure exceeded expectations and helped fuel an eight-week stock-market surge as investors bet an economy recovery would lift stock valuations. The rally faltered in December.

Other favorable indicators, such as rising consumer confidence and falling unemployment, hold out hope the long-awaited recovery might yet take place in 2003.

Jarrett is moderately optimistic. "We think the fundamentals are in place for a recovery [next year]. As I said, the inventory situation is very lean. Manufacturing will benefit from that steadily as the year develops. The consumer sector probably won't lead the economy next year, [but] we already think there are early signs of a rebound in investment spending," Jarrett said.

Any good news from the United States would be especially welcome in the European Union, now in the throes of a two-year slowdown that is expected to last at least until the middle of next year.

The situation is bleakest in Germany, the EU's largest national economy, as unemployment stays stubbornly high at around 10 percent and corporate spending remains low. Deutsche Bank economist Stefan Schneider said he expects the German economy to grow just 0.5 percent in 2003, after essentially no growth this year. He cited several reasons for this. "The world recovery didn't happen. Expectations were disappointed. That had major implications for investment spending. And the third and probably[, for most observers,] most surprising factor was that private consumption [consumer spending] actually declined in 2002, where most people actually thought private consumption would grow," Schneider said.

Schneider said consumer spending fell as Germans -- facing possible unemployment and continued economic uncertainty -- put more of their money into savings accounts.

The global economic slowdown has also hit Britain, the largest European economy outside the euro-zone. It forced Gordon Brown, the country's chancellor (finance minister), to cut his growth forecasts last month.

Real GDP, he now says, should grow 1.6 percent this year. That's down from the government's earlier forecast of 2-2.5 percent. Brown said that Britain has fared better than other countries. But he said stock-market falls, higher oil prices, the post-11 September uncertainty, and corporate accounting scandals have all dented the British economy too.

The slowdown in the euro-zone also revived debate in Britain about the merits of signing up to Europe's single currency. The "no" camp says it bolsters their arguments: They say a one-size-fits-all interest rate for Europe's diverse economies is clearly not working. Instead, they say, it's only making things worse for the countries having the hardest time. And the strict budget rules for the euro-zone countries mean they can't spend their way out of a crisis.

France's economy has been almost as sluggish as Germany's this year. The OECD expects France's economy to grow by a modest 1 percent this year, its slowest rate since 1996.

And like Germany, France faces a warning from the European Commission for going over the euro-zone's budget-deficit limit of 3 percent of GDP.

The Frankfurt-based European Central Bank, or ECB, in contrast with its U.S. counterpart the Federal Reserve, has been slow to reduce interest rates to stimulate growth. The bank finally did cut rates earlier this month, but the benchmark euro rate still stands a large 1 1/2 percentage points above its U.S. counterpart.

The ECB has also slashed its projections for growth of the euro-zone economy both this year and next. In a report published today, the bank forecast growth of just 0.6-1.0 percent in 2002, down from 0.9-1.5 percent. Projected growth in 2003 is now 1.1-2.1 percent, down from 2.1-3.1 percent.

Bank critics argue that the reluctance of the ECB to cut rates has prolonged Europe's economic misery by keeping the price of bank loans artificially high. The bank, in its defense, points to the danger of inflation from rising commodity prices, like fuel oil. The OECD points out that inflation in the euro-zone has remained above the ECB's target of 2 percent despite the economic slowdown.

One ray of sunshine -- even if more symbolic than real -- for the European economies was the euro. The EU's common currency rose to parity with its rival, the U.S. dollar, reaching a high of around $1.02 at mid-year. In the first years of its existence, the euro lagged behind the dollar as dollar-denominated stocks and bonds were considered more attractive because of their better growth prospects.

The currency's rise, however, was more a story of dollar weakness than euro strength. One factor weighing on the dollar was the interest-rate differential between dollars and euros that spurred investors to buy euro-denominated bonds and money markets that now give a higher rate of return.

Economists say the ever-present prospect of war with Iraq could hurt the dollar by raising oil prices and also forcing the government to borrow money to finance the war, thus leading to a rise in interest rates. Higher oil prices and interest rates would nip any U.S. economic recovery in the bud.

Paul Ashworth, an economist at London-based Capital Economics, said: "Higher oil prices will mean that U.S. consumers certainly will not be able to afford such a wide range of goods, and it will reduce their purchasing power. So it will have the dual effects of both reducing demand and increasing inflation in the economy."

Indeed, many economists say the possibility of war with Iraq is the single darkest cloud on the global economic horizon looking to 2003. Schneider said: "The major factor here is what's going to happen with Iraq. I think that's something that's really currently a big albatross around the world economy's neck. Before we get resolution there one way or the other, [any] kind of recovery will be rather subdued."

Even if war does not come, economists are cautioning not to expect big things in 2003. Any U.S.-led recovery would not be felt elsewhere in the rest of the world for months, meaning Europe's fortunes won't start changing until mid-year at the earliest.